EagleTribune.com, North Andover, MA

July 2, 2012

Vacation Rentals – Huge Rents… Any Profits?


Zillow

Syndicated — Borrowing from the boat owners' passel of proclamations, may I suggest: "The best two days of a vacation rental owner's life are the day he buys it and the day he sells it...."

Those who live near the shore often hear rumors about the piles of money that vacation rentals bring in. "The summer months' rental income pays for the entire year's mortgage," folks will say. That may be true, but what about the rest of the expenses?

The problem with vacation rentals is twofold:

1. Operating expenses related to vacation rentals are similar to those of a hotel - 60 percent to 75 percent of revenue; and

2. Prize vacation properties come with enormous price tags and staggering monthly mortgages, property taxes, insurance, etc. Those are fees that must be paid, whether your occupancy is 100 percent or zero.

How can revenue operating expenses be so high, you ask? Vacation rentals, even a single property, requires a lot of work. You'll need to:

All these tasks take time, which is why property management companies are able to command high fees. Sure, you can do the work yourself, but either way you're going to have to fork over cash for furniture, sheets, towels, utility bills, etc. All those costs add up, so it's easy to see how roughly 75 percent of your revenue - not including your own time or your mortgage payment - is paid out in expenses.

By contrast, a moderately priced, single rental unit or apartment should have an expense ratio of 35 percent to 45 percent. That's 30 percent less than a vacation rental.

Want another comparison? Vacationers come and go frequently, which means the property manager may face two to three crises each week, all of which are "urgent" because the renters are on vacation and want everything - the grill, the hot tub, the window locks - to operate smoothly for the short time they're with you.

On the other hand, a typical non-vacation rental unit should need attention five to seven times per year with, perhaps, one of those problems being urgent.

Simply put: a dollar of vacation rental income is really worth about a quarter (25 cents of net operating profit on each $1 in income), while a dollar of rental income on a non-vacation property is worth 55 to 65 cents. (Those figures, again, are before the mortgage is paid.).

For those who would like a detailed financial picture, I've included an estimated pro-forma financial statement below on a typical Mission Beach town home or condo. Look at the Cash on Cash Returns; a vacation rental may have a negative cash on cash return of 10 percent or more.

Click on graphic to make larger:

And be warned: when the economy sputters, so will your rental revenue stream. People will cancel vacations and bargain hard on weekly rental rates, while you must continue paying all your monthly bills.

Finally, remember that there is little independent, unbiased information available that will allow you to do your due diligence on rents, vacancy and expenses. That lack of information means "pass on that investment" for most property investors who have "already learned that lesson!"

Disclaimer: Your vacation rental experience may differ from what's described here. This is simply a glimpse at what I believe to be a typical financial picture for a Mission Beach, San Diego, beachfront condominium vacation rental. You can pencil out your deal to see how any property you may purchase will compare. One sure thing: it's impossible to know the real numbers of a property without reviewing the current owner's tax returns, which you'll probably never see. And a lack of information in the investment world equals a much higher risk.

Related:

Leonard Baron, MBA, CPA, is a San Diego State University Lecturer, a guest blogger on Zillow.com, the author of several books including "Real Estate Ownership, Investment and Due Diligence 101", and loves kicking the tires of a good piece of dirt! See more at ProfessorBaron.com.

Note: The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinion or position of Zillow.